THE UNIVERSITY OF TOKYO GRADUATE SCHOOL OF PUBLIC POLICY

RESEARCH PAPER Tokyo a possible HUB for LNG spot trade

Supervisor JUN ARIMA

Professor for Energy & Environmental Policies Graduate School of Public Policy

University of Tokyo

ARTHUR EL MEDIONI (51-158230) arthur.medioni@gmail.com

May 18th 2017

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AcknowledgementsWorkingonthispaperhasbeenoneofthemostenjoyableandstimulatingthingsIdidinrecentyears.Iwouldliketosincerelythankmysupervisor,ProfessorJunArima,forthequalityofhiscomments,whichenabledmetoconsiderablyimprovethispaperandforhisconstantavailability.FortheirproofreadingandcommentsIwouldliketosincerelythankProfessorRobertoOrsi(UniversityofTokyo)andmybrotherPaul.During the last three months I had the pleasure to meet and interview a number ofprofessionals from the industry, scholars, and ministry officers. Our conversationsdeeplyenrichedmyknowledgeontheLNGbusiness.ForthatIwouldliketoexpressmydeepestgratitudetothosementionedbelow:KosukeARAKISeniorManager,researchInstituteofMarketStructureTokyoCommodityExchange,Inc.

FumiakiARIYOSHIAssistantDirectorOilandGasDivisionMinistryofEconomy,TradeandIndustry

JavierCALVOLNGSalesManagerAsiaPacificGasNaturalFenosaLNG

JosephCHOGroupRepresentativeinKoreaTotalGroup

VincentDEMOURYGeneralDelegateInternationalGroupofLiquefiedNaturalGasimporters(G.I.I.G.N.L)

HubertDEMESTIERDUBOURGFormerChiefRepresentativeforNorth-EastAsia(Japan,Korea,Taiwan),TotalGroup

HiroshiHASIMOTOSeniorAnalystGasGroupTheInstituteofEnergyEconomics,Japan

DaisukeHIROTAPrincipalDeputyDirectorOilandGasDivisionMinistryofEconomy,TradeandIndustry

JiroMIYAZAKITrade&OriginationHead–LNGEnergyTradingDept.SumitomoCorporation

ShizukaMORIKANEAssistantManager,researchInstituteofMarketStructureTokyoCommodityExchange,Inc.

YoshitoSEBEManagerFuelTransactionGroup3JERACo.,Inc.

JonathanSTERNDistinguishedResearchFellowNaturalGasResearchProgrammeTheOxfordInstituteforEnergyStudiesUniversityofOxford

HiroyukiTAKAIPresident&CEOSumitomoCorporationGlobalResearchExecutiveOfficerCorporateGroupSumitomoCorporation

NobuoTANAKAChairmanTheSasakawapeacefoundationFormerExecutiveDirectoroftheInternationalEnergyAgency

TakuroYAMAMOTODeputyGeneralManagerEnergyResourcesPlanningTokyoGas

StevensZHANGGas,renewables&PowerVicePresident,GasTotalGroup(China)

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TableofContents

Introduction..................................................................................................................4

ChapterISpecificitiesofLNG..................................................................................51.1Liquefaction....................................................................................................................51.2Shipping...........................................................................................................................51.3Regasification&Storage............................................................................................6

ChapterIILNGMarket...............................................................................................62.1Exportcountries...........................................................................................................62.2Importcountries...........................................................................................................72.3Contracttypes................................................................................................................72.4Japanesemarket...........................................................................................................9

ChapterIIIAsianHUBs...........................................................................................103.1TheneedforanAsianHub......................................................................................103.2AdvocatingforaTokyoLNGHub..........................................................................103.3LimitsofaprospectiveTokyohub.......................................................................113.4ShanghaiorSingaporeHub.....................................................................................153.5PossiblesolutionsforaTokyoHub......................................................................17

Conclusion..................................................................................................................18Bibliography..............................................................................................................20

ANNEX..........................................................................................................................23

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Introduction

Inastudyconductedin2015theInternationalEnergyAgency(IEA)demonstratedthat,considering average CO2 emissions per kWh of electricity produced in OECDmembercountriesfrom2009to2013,naturalgasemits400gCO2/kWhwhilethisvalueis675gCO2/kWhforpetroleumandbetween875and1035gCO2/kWhforcoal(IEA,2015aandAnnex,Table1.a,PowerPlantsAirEmissions).Moreglobally, in the lightof therecentParis agreement in2015 (COP21),we seea trend to replace coalbygas in thepowergenerationbusiness (respectively representing40%and23%of total consumption in2012).Asanexample,Beijing’selectricityisnowcompletelyproducedbymeansofgas-firedpowerplants,as the lastcoal-firedpowerplanthavebeenshutdown(TheJapanTimes,2017).Inaddition,theneedsofgrowingeconomies–especiallyinAsia–makeclearforusthatthe global gas market has a bright future. Chinese, South Korean and Taiwanese gasconsumption in2030are forecasted toreachrespectively340.7,45.5,and32.1billioncubicmeters(Li,2011andRogers,2016).Thatwillrepresentrespectivelyagrowthof220%, 5.5%, and 118% from 2010 level (IEA, 2016a). Natural gas will thereforecontinuetoplayanimportantroleintheAsianenergymarketespeciallyinitsliquefiedform (Stern, 2014). In Japan, demand will reach between 80 and 120 billion cubicmetersdependingonthenuclearsituation, i.e.whethertheshareofnuclear-generatedenergywillbeat21%or11%intheJapanesepowermix(Rogers,2016).DespitethepromisingfutureofgasinAsia,thereisnorealindexintheregionreflectingthesupplyanddemandpricefornaturalgas/LNG.However,inthemeantimegas-to-gascontractsrepresentedabout60%oftheLNGtradeinEuropein2015(IGU,2016)whilethe North American market is dominated by the gas-to-gas Henry Hub price (Reed,2013).Addressing this shortcoming, in May 2016 the Japanese government expressed thewillingness to establish an LNG trading hub in Tokyo through a document entitled“StrategyforLNGMarketDevelopment,CreatingflexibleLNGMarketandDevelopinganLNGTradingHubinJapan”publishedonMay2,2016bytheMinistryofEconomy,TradeandIndustry(METI,2016).In contrast to US and Europeanmarkets, it appears to us that the financial sector isunabletoprovideacleargas-to-gaspriceinAsia.Forthatreason,thesubjectofpossibleLNG HUB in Tokyo represents an interesting topic to study, as it could represent asolution to determine a gas-to-gas price in Asia. Themain question here is: carefullyconsideringthreekeyfactorssuchasliquidityofthemarket,physicalissue,andcurrenttrends,couldTokyoreallybecometheLNGHUBforspottradeinAsia?This researchpapersupports the thesis thatTokyo isunlikely tobecomeanLNGHubforAsianspottradeduetotheimportantconstraintintermsofliquidityandthelackofa clear index representing supplyanddemandofLNG in the region.We think insteadthathubsinAsiacouldbeimplementedinSingaporeandShanghai.Thisstudyconcentratesthereforeprimarilyonthestudyofthosefactorswhichshouldbepresent if thewillingnessof the Japanesegovernmentandeconomics realityare toallow the rise of Tokyo as the LNG HUB for spot trade in Asia. To evaluate thatpossibilitywewill analyseproduct specificities,market structure, global trends,METIproposalsandplayersresponses.Inadditionwewillbeabletounderstandthepossibleissuespreventinghubimplementation.

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ChapterISpecificitiesofLNG

LNG is aparticularproduct. Inorder tounderstandhowphysicalparticularities couldhaveaninfluenceonfinancialtransactionswewillanalyseLNGspecificitiesthroughthefourphasesofitshandling:liquefaction,shipping,regasificationandstorage.

1.1Liquefaction

Liquefaction is a method used to transport Natural Gas (NG) through vessels. Thisprocessdecreasesthevolumeofnaturalgasby600times.LiquefiedNaturalGas(LNG)ismostlycomposedofmethaneand isacryogenic liquidatapproximately -162°C.Forcountrieswhichdonothaveanypipelineaccess,supplyofnaturalgasthroughvesselsistheonlypossibility to importnatural gas. For instance,due toparticulargeographicalconditions(islands,isolatedcountries,etc.)Japan,South-Korea,andTaiwanrepresentedin201653%oftheworldLNGimport(IGU,2016).Inorder tobeexported in liquid form, natural gasneeds tobe liquefiedat anexportterminal.Theinitialcostofanexportterminalisimportant,ofteninthetensofbillionsdollars.Thatimpliesthenecessityofsecuringsufficientcashflowtopaybacktheinitialcost.Thisleadstotheprevalentuseoflongtermcontracts(Corbeau,p23,2016).

1.2Shipping

“When vaporized, its flammability range is between approximately 5% and 15% byvolume, i.e. a mixture with air within this range of concentrations is flammable”(Vanema,2011).ThisparticularityofLNGmakes itverycomplicated to transportandhence implies different types of vessels. “The current LNG fleet is dominated by twomain types of vessel designs, i.e. the membrane tank designs and the spherical tankdesigns.” (Vanema, 2011). The imporance of these technical details for our studywillbecome apparent later on when the compatibility issue between LNG terminal andvessels will be considered. In 2016, the global LNG fleet was made up of 24%Mosscarrier’s type (spherical tank) and 70% by Membrane carrier’s type. The total fleetconsistedof478carriers(GIIGNL,2017).It is important to keep inmind that during the transport phase part of the LNGwilldisappearby evaporation.We referhere to theBoil-OffRate (BOR),which representsthepercentageof LNGvolumeevaporatedperday.This ratio fluctuates from0.1% to0.15% for ladden voyage, and 0.06% to 0.1% for ballast voyage depending on ships(Dobrota,2013).Compared to the oil industry, the construction cost of an LNG tanker is significantlyhigher than an oil tanker. Average estimation of an LNG tanker construction cost isabout1.9billiondollars (OILGAS360,2015)permillion tonsoil equivalent,when is itonly 0.5 billion dollars per million tons oil equivalent for an oil tanker (Bockmann,2013).Thosecosts,aswellasthepreviouslymentionedones,clearlyestablishtheneedoflargeinitialinvestmentsfortheLNGbusiness,againespeciallyifcomparedtooil.Thecapital intensivityofLNGbusiness explains theneedof securinga stable cash-flow torefund the initial investment. As anticipated above, this leads to the predominance oflong-termcontractagreementsasthestandardtradingformat.

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1.3Regasification&Storage

RegasificationterminalsareusedtotransformtheLNGbackinitsgasform.Wemaycallthemimportterminalorregasterminallaterinthispaper.Priortodelivery,anLNGvesselthathadneverbeentoaterminalbeforeneedtopassaShip-Shore Compatibility Study, to ensure that the terminal can actually receive thatvessel. Insomecases, forexample, thegangwayisnotadaptedtotheship.Since2007two new types of vessels have been built, the Q-Flex and Q-Max, with a capacity of210.000and266.000m3respectively.TheissueisthatnotallterminalsreceiveQ-Flexor Q-Max due to their size. In 2016, 19% of the fleet was made up of carriers over170.000m3(GIIGNL,2017).Offshore terminals couldbeused toovercome the issueof shipcompatibility,but it isstillaveryundevelopedtypeofregasificationterminal,thereforewewillnotconsideritinthisstudy.Therearetwotypesofstorage,namelystoragageofgasingasform(NG)andinliquidform (LNG). Asmost of theAsian countries only use the LNG storage system,wewillonly refer to that type.As invessels,LNGstoragesalsohave tocopewith theBoil-OffRateissue(evaporation).“Storagetanksaretypicallydesignedtoreducetheingressofheatfromthesurroundingsandsolarheatingsothatvaporizationislessthan0.05%ofthetotaltankcontentperday,althoughthiscanvaryfrom0.02to0.1%”(Dobrota,2013).Thisissueleadstohighmaintenancecosts.

ChapterIILNGMarket

2.1Exportcountries

LNGexportsworldwideincreasedby15%from223MTPAin2010to258MTPAin2016(IGU,2017,2016,2015,2014,2013,2011,2010),amodestgrowthwithsmallchangesduringtheconsideredperiod.Wedidnotseeacompleterestructurationofmarketplayersbetween2010and2016,new players such as Angola and Papua New Guinea (PNG) are still modest, as theyrespectivelyexportedin20160.8MTPAand7.4MTPA.WenoticetheimportantincreaseofAustralianLNGexport,+132%from2010 to2016, shifting from19.1 to44.3MTPA.War affected the exports of Yemen and Libya respectively diminishing from 4.3 and0.2MTP in 2010 to 0MTPA in 2016. One interesting fact is the shift of US from“importingcountry”(importbalance+7.9MTPA)in2010to“exportingcountry”(exportbalance +2.9MTPA) in 2016, and Egypt from “exporting country” (export balance+7.1MTPA)to“importingcountry”(importbalance+6.8MTPA).Except the mentioned changes, the nine main exporters remain Qatar, Indonesia,Malaysia,Australia,Nigeria,Trinidad,Algeria,RussiaandOman,with85%marketsharealltogetherin2010and86%in2016(Annex,Chart2.1.1,2010-2016LNGExportsandMarketSharebyCountry).Lookingat future trends,U.S. isnowclearlyengaged inahugeLNGexport expansion,usingregasification terminalsconverted into liquefaction terminals (Annex,Map2.1.2,USLNGExportProjectsMap).WhenHenryHubpriceraisedupto14$/MMBtuin2000s,companies built import terminals to use oil-linked formula, cheaper at that time.Nevertheless, since Henry Hub price decreased below 5$/MMBtu it was no longerprofitabletoimportLNGtoUS,andthereforetheyconvertedimportterminalstoexportterminals, under the initiative of Cheniere Energy. The US committedwith long-term

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contractstoexportavolumeofover37MTPAin2020(GIIGNL,2012,2013,2014,2016,2017).With71MTPAexportcapacityoperatingorinconstruction(Annex,Table2.1,US LNG Export Projects) theUSwill certainly be the second larger LNG exporter in theworldby2020.Thatwillhaveanimportantimpactoncontractnegotiationsforatleastthreereasons.Firstly, thepricemechanismofUSexports iscalculatedbasedonHenryHubprice(furtherdetailsinpart2.3),thusagas-to-gaspricenotindexedoncrudeoil.Secondly,becausetheUSexportsdonothaveadestinationclause(apartfromEARandITAR lists1). Lastly, becausewith this huge volume added to themarket, we are nowfacinga“buyers’market”,whereitiseasytorenegotiatecontractsonmuchbetterbasis.From2010to2016theworlddemandofLNGincreasedby33MTPA.Within5years,theUS production will add 71MTPA on the market, and we will, therefore, face anoversupplied market, most likely for the next decade, especially if Japan restarts itsnuclearpowerplants,thusdecreasingitsdemandby10to15MTPA(Stern,2014).

2.2Importcountries

Ontheimportside,severalchangeshaveoccurredduringthepast6years.First of all, after the Fukushima accident, Japan increased its imports of LNG from71MPTAin2010to88MTPAin2012,thus+24%intwoyears(Annex,Chart2.2.1,2010-2016LNGImportsandMarketSharebyCountry).Then,wesawaclearshiftfromEuropetoAsianintermsofmarketshare.Whilein2010UK, Spain, France and Italy represented 23% of theworldwide imports, in 2016 thisshare shrank to 11% (Annex, Chart 2.2, 2010 - 2016 LNG Imports andMarket SharebetweenEuropeandAsia).At thesametimetheshareof Japan,S.Korea,Taiwan,andChina increased from 56% to 62% (mainly due to Chinese demand expansion, +6%sharein6years).Chinese and Indian imports of LNGhave experienced the fastest growth in theworld,respectively increasing from9.5and9.3MTPAin2010to26.8and19.2MTPAin2016.Bothcountrieswillrepresentthevastmajorityofthefuturedemandgrowth,asin2025Chinese LNG demand should reach 80MTPA, and 29MTPA for Indian demand (Stern,2014).As previously described, US imports share shifted from4% to 0% as it became a netexporter,andEgyptshareshiftedfrom0%to3%.In terms of future prospects, we clearly see a trend in south Asian countries, withimportssharesofThailand,Malaysia,SingaporeandPakistangoingfrom0%in2011to3,5%in2016(IGU,2015).

2.3Contracttypes

InthispartwewilldescribeandanalyzealldifferentformsofLNGcontractsthatcouldbesignedbothinJapanandworldwide.Historically the oldest type of contract is the oil-linked contract, introduced to solveearlypricingproblem(Corbeau,p.36,2016).ForJapan,onespecificoil-linkedcontractistheJCC,standingforJapaneseCrudeCocktail(IGU,2011).Itiscalculatedbasedonanaverageprice of crudeoil imported to Japan (numbers givenby theMETI).Oil-linkedpricesformulalookslike:

P=C+βX+S

1Detailliston:http://www.export.pitt.edu/embargoed-and-sanctioned-countries

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WherePistheLNGprice($/MMBtu),Cisthebaseprice($/MMBtu),βisthepriceslope,XistheOilPriceindex(JCC,brent,etc.)andSistheShipmentCharges(Flower,2012).InearlyJCCcontracts,theslopewasthemostimportantelementandusedtobe14,85%(Corbeau,p36,2016).Later in1990s, inorder toprotectbuyers fromhighpricesandsellersfromlowoilprices,theS-curvesystemwasintegrated,increasinganddecreasingpriceoutsideacertainrange.InNorthAmerica,deregulationofgaspricesstartedinthe1980s,movingtowardsasocalledhubbasedprice:theHenryHub.HenryHubisthepriceofgasgivenattheNewYorkMercantileExchange (NYMEX) for themonthof lifting.As theUS isbecominganexportingcountryaswesawinpart2.2,thispriceisnowusedworldwideinLNGpriceformula(FreeOnBoardbasis).AsgivenbyCheniereEnergyInc.itisconstructedassuch:

𝑃 = 1.15 ∙ 𝐻𝐻 + 𝐵WhereP is theLNGprice,HH is theHenryHubpriceandB isa constantdifferent foreach contract (ranging from 2.25$/MMBtu to 3.5$/MMBtu), offering an alternative tooil-linkedcontractsforAsianbuyers.Recently some Japanese buyers have been using JLC (Japan LNG Cocktail). JLC is anaveragemeasurebasedonallLNG imports in Japan(monthlyprice), thusnowmostlyreflectingoil-linkedprices.GoodforhedgingspotinJapan,itmightfacedifficultiestobeusedinneighborcountries,anditisnotameasureofgassupply/demand.A possible Asian gas-to-gas price could be the JKM price, standing for Japan KoreaMarker.ItisadailypriceforspotvalueofLNGcargoforacertaindeliveryperiod.JKMisassessed by Platts “based on trades, bids and offers observed by S&P Global Plattspricingspecialists.PlattsLNGassessmentsaremarket-on-close(MOC)pricesprevailingat 16:30 Singapore time or 08:30 GMT on a standard ship size. Market players areregularlycontactedbyphone, instantmessage,emailor faceto facemeetings.”(Platts,PlattsJKMmethodology)TheMETI established in April 2014 a spotmarker called JOE (Corbeau, p482, 2016).Nevertheless, by the end of 2015, JOE has not been used either as marker or index(Corbeau,p.482,2016).Therefore,wewillnotgivemoredetailsonthispricereference.InAsiatwoindexeshavedbeenlaunchedforspotandfuturepriceofLNG.InJapanJOEisalsothenameofacontractlaunchedbyTOCOMinJapan.Itgivesaspotandfutureprice(deliveryandnon-deliverycontract).SLIngistheSingaporeanspotandfuturepriceforLNGlaunchedbySGX,it isbasedonassessement,similartoJKM.WewillgivemoredetailsonbothindexesinChapterIII.InEurope,twospotpricesareavailable,theNBPprice(inLondon)andtheTTFprice(inAmsterdam).ThosepricecouldbeusedforarbitrageinAsia.

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2.4Japanesemarket

In this partwewill describe in detailsmarket players and issues in the Japanese gassector. There aremainly three types of players: gas utilities using gas for residential,commercial, andpartially industrial purposes; power companiesusing gas toproduceelectricity;andindustryfortheirownneeds.“Powergenerationisthelargestnaturalgas-consumingsectorinJapan,withashareof69.8%in2014.In2003,theshareofpowergenerationwas67.4%;however,inthemid2000s, gas demand grew faster in commercial and public services than in powergenerationwhoseshare in total gas consumptiondeclined to63.6% in2010. In2011,demand from power generation surged in the aftermath of the nuclear power plantshutdownanditsshareincreasedto67%,growingsteadilysince.”(IEA,2016)Thereare203citygasutilities in Japan(JGA,2016).However,only11havetheirownre-gasterminal,namelyHokkaidoGas,CityofSendai,TokyoGas,ShizuokaGas,TohoGas,OsakaGas,HiroshimaGas,ShikokuGas,OitaGas,SaibuGasandNihonGas(IEA,2016a).AspecificityofJapanisthehighnumberofregasterminals:33(22yearoldonaverage)in total (ANNEX,Table2.4,Regas terminals in Japan).Aswespecified inpart1.3,newcargoscalledQ-FlexandQ-Maxmaynotbeabletodelivertoeachregasterminal.ThetablebelowprovidesmoredetailsaboutthecurrentsituationinJapan(GIIGNL,2016aandIEA,2016a).LiquiditycouldbeaffectedastradermightnotbeabletosellaQ-FlexoraQ-Maxtocertainregasterminals.Problemscouldalsooccurregardingthedesignofthevessel,i.e.whethersphericalormembranetanktypes..

Numberofterminals

Regascapacityinmillionm3peryearof

LNG

%oftotalvolume

CouldreceivedaQ-Flex 14 307 65.5%

CouldreceivedaQ-Max 3 54 11.5%

CouldnotreceivedaQ-Flex 11 99 21%

CouldnotreceivedaQ-Max 18 306 65%

NottestedforQ-Flex 8 64 13.5%

NottestedforQ-Max 12 110 23.5%

Total 33 470 100%Source:EIA,2016aandGIIGNL,2016a TheFukushimaaccidentplayedan importantrole in theLNGbusiness in Japan. Sincetheaccident,mostofthenuclearpowerplantshavebeenshutdown.Asstatedabove,apossible restart operation that will affect the gas demand by 10 to 15 MTPA (Stern,2014).

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ChapterIIIAsianHUBs

3.1TheneedforanAsianHub

The idea of an LNG hub in Tokyo strongly appears in the debate in 2011, after theFukushima accident. Simultaneously, the oil pricewas reaching a peak over 110$ perbarrel, and as gas was traded through oil-linked contracts it reached a peak around22$/MMBtu in 2012 (ANNEX, Chart 3.1, 2010 - 2015 Gas Prices). It was the worstmoment for Japan,as thecountryneeded to increaseLNGsupplyby17MTPA inshortterm to offset the shutdown of nuclear power plants. That created a tremendousfinancialburdenforthecountry.ThereforetheMinistryofEconomy,TradeandIndustry(METI)thoughtofanewpricemechanisminordertodecreasethecostofLNGsupplytothecountry.Forthatpurpose,METIpublishedin2016adocumententitled“StrategyforLNGMarketDevelopment,creatingflexibleLNGMarketandDevelopinganLNGTradingHubinJapan”.Aswesaidabove,mostoftheLNGcomingtoJapan,China,Korea,TaiwanandotherEastAsian countries is priced in relation to oil, or,more recently, toHenryHubprice.Oil-linked price was a good mechanism when oil and gas were substitutable in powergeneration.Nevertheless,thesedaysoil-firedpowerplantsarenolongeroperating,thusgascouldnotbesubstitutedforoilaseasilyasitwasinthepast.Oil-linkedpricedoesnotmakemuchsenseanymoreanddoesnotreflecttherealityofthe market; as oil prices fluctuates reflecting OPEC production target, as well as oildemandandsupply.Therefore,AsianLNGbuyersareunnecessarilyexposedtotensionsonoilmarket,whicharenotmuchconnectedtothegasmarket,asitcouldbeinthepast.Onanotherhand,HenryHubrelatedpriceformulareflectssupplyanddemandofgasinNorth American market only. As a consequence, by using Henry Hub formula, AsianbuyersexposethemselvestoNorthAmericanmarketfundamentals(Stern,2014).AnAsianhubwouldsolvebothoil-linkedandhenryhubissuesbyreflectingthesupplyand demand price of LNG in Asia. From theoretical perspective, a healthy situation iswhen price of a commodity reflect the demand and supply of this commodity in aspecificregion(Stern,2013).Another matter is the recent oversupply market (“buyers market”), bolstered by gasfromAustraliaandUS(ANNEX,Table3.1,US LNG Export Projects).Lookingatthesecircumstances,itwouldbegoodtimingtoestablishahubforspottradewithoutfearingasupplyshortageonthemarket.However, ifwe agree that a hub is needed inAsia, does thatAsian hubneed to be inTokyo?Doesitneedtobeasinglehub?Virtualorphysical?Wewilltrytoanswerthosequestionsinnextsections.

3.2AdvocatingforaTokyoLNGHub

ThepositionofJapanastheworldlargestLNGbuyeriscertainlythestrongestargumentin favour of a Tokyo hub. With 33 LNG regas terminals, 83.3 million tons of LNGimported in2016,andastoragecapabilityof12.5million tonsofLNG(IGU,2017andIEA,2016a),JapaniscertainlybymanyaspectsthebestcandidateforanLNGhub.Inadditiontomarketdomination,Japanhasproceededtoaliberalizationofelectricityand gasmarket in order to stimulate competition in thepower generation sector andgas-retailingsector,withtheaimofdecreasingthepriceforfinalusersandofincreasing

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the liquidity of LNG in themarket. Concerning the electricity sector, sinceApril 2016METIhasimplementedafullretailcompetition.Regarding the gas sector, from April 1st 2017 the Gas Retail Market will be fullyliberalized. 24.7 million households and 1.2 million shops & offices will be able tochoose freely their gas supplier. That represents a 20 billion dollarmarket. Networktariffs will be regulated. Theoretically, since April 2017 METI implemented a TPA(ThirdPartyAccess)onregasterminalandpipeline.Wesayhere“theoretically”becauseinpracticethatwillbemuchmorecomplicatedtoimplement(wewilldevelopthatissueinpart3.3).Concerning distribution, METI determined three main targets: “Securing regionalmonopolies and regulated tariffs for gaspipeline servicebusinesses. Securing a third-party access system on gas pipelines. Formulating amechanism that the governmentmay determine the disputes on connecting pipelines.” (METI, p10, 2017)) If that isimplemented,itwillallowthepossibilityfornewactorstocomeonthemarket.OtherfactorsinfavourofanLNGhubinTokyocouldbethepoliticalstabilityofJapanaswell as the strong wish of the Japanese government to establish such hub. For thatpurpose, METI launched a spot price named JOE, reported every month in METIpublication (arrival based price). In June 2014 Tokyo Commodity Exchange (TOCOM)andGingaEnergystartedanOTCLNGplatform(confusedlynamedalsoJOE)toaccess:Non-deliverableForward/Futures. InthebeginningofApril2017TOCOMannouncedlaunching the “new LNG contracts on its new OTC trading platform” (TOCOM, 2017,details in ANNEX, Table 3.2, JOE’s new LNG contract). This new contract includesdeliverable/non-deliverable types of contracts and, if contracts are doingwell (liquidenough), TOCOM agreed with Platts that price of JOE will be reflected in JKM. Theadvantageofthatcontractisananonymousplatformtotradetoputbidandoffer.ThismethodsisactuallytheoreticallymuchmoreeffectivethanphonecallsassessmentusedbyPlatts.At last, theparadigm shift startedwith imports of LNGwithHenryHub relatedprice,offeringtotheJapanesecompaniesmoreflexibilityonthecontract.ThiscouldbehelpfulinordertoestablishanLNGhubinTokyo,becauseHenryHubrelatedcontractsdonotincludedestinationclause,andbuyerscouldeasily re-saleLNG. JapanesecorporationsarethebiggestbuyersonHenryHubrelatedcontract,withabout20-25%shareinLNGexportcontractsfromUS(Stern,2014).

3.3LimitsofaprospectiveTokyohub

At thisearly stageofadvocating foraTokyoLNGhub, it is important topoint severalissuesthatmaypreventthehubtobeestablishedinthiscity.“Furthermore,thetransparencyandreasonablenessinpricedeterminationwillenhancethe appeal of LNG as an energy source and will promote the shift to LNG and thecreationofnewLNGdemand.”(METI,p6,2016).Withthisstatement,itclearlyappearsthattheideaoftheMETIistofindamechanismtolowerLNGpriceasthecountryisanimportantimporterofLNG,creatingafirstissue:suspiciononsellingside.Indeed:whywould sellers trust aprice emerging fromahubdedicated to lower thepriceof LNG?Thatfirstissue,clearlyrevealsthefirstweaknessofTokyocandidature:JapanisaheavyimporterofLNGwithanationalproductionaround2MTPAofLNG in2015, coveringlessthan2%ofdomesticneeds(IEA,2016a).IncomparisontocountrieshostinganLNGhub, in 2015,USproduced560MTPAof LNG,UKproduced30MTPAof LNGand theNetherlandsproduced88MTPAofLNG(IEA,2016a).Animportantdomesticproduction

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isimportantforthepriceindextoappearmoreneutral.Onthataspect,Shanghaihasanadvantage on Tokyo as China produced 98 MTPA of LNG in 2015 (IEA, 2016a).SingaporedoesnothaveadomesticgasproductionbutasLNGimportationsarereallysmall,thusitstillappearsasneutral.Asecondissue,whichcouldpreventTokyofrombecomingahub,isthelackofliquidityon LNG market. Indeed, in order to ensure a good price mechanism, the amount oftransactions should increase to assure liquidity on themarket. This is very importantbecauseiftheliquidityisnotgoodenoughthenitcouldimplyshortagesaswellasaveryhighvolatilityofprices.Liquidity is indeed the core problem; regarding the possible LNG hub in Tokyo, wefoundseveralissuesimpactingliquidityonthemarket.SomeofthoseissuesarepurelyrelatedtoJapanandsometothenatureofLNG.Nevertheless,bothwillbeobstaclestothedevelopmentofanLNGhubinTokyo.WewillfirstassessthoseissuesofliquiditypurelyrelatedtoJapan.Themostimportantissueisthestructureofcontract inJapan,sinceJapanesecorporationsareusedtobuyon long-term contract basis, and in so doing they diminish the opportunities for spotandshort-termtransactions.To have a better understanding of that issuewe computed all the existing long-termcontracts (more than 4 years) signed by Japanese companies (as given in GIIGNLreports). We also forecast a possible LNG demand in Japan based on low and highnuclearscenario(asgiveninStern,2014andIEA,2016b).On“LNG2017-2030supplycontractedbyJapanesecompaniesbefore2017andcontestabledemandforecast2017–2030” (ANNEX, Chart 3.3, Future room for spot transaction in Japan)we can see thefuturequantityalreadycontractedbyJapanesecorporationuntil2030,atthesametimewecanseedemandforecast,thusthepossibleroomleftforspottrade.Whatweseeisthat Japanalreadysecuredmorethan67%oftheJapanesedemandinthe lownuclearcasein2025and90%in2021.IftheJapanesedoesnotsignanynewcontractby2025andifnuclearpowerplantdoesnotrestart(which isnot theofficialposition fromJapanesegovernment) theroomforLNGspottradewillbe25milliontonsin2025.Thatwillrepresentabout0.6cargoesperday (basedon150.000m3averagecargoes).So “if theminimumtradewasonewholecargothisislikelytobeabarriertodevelopingliquidity”(Stern,p42,2014).Inadditiontothat,westronglydoubtthatJapanesecompanieswouldnotreneworsignnewlong-termcontracts.Infact,sinceoilisverycheapinthesedaysandthemarketoversupplied,Japanese corporations tend to renegotiate oil-linked contracts on better terms,decreasing the slope from 14-15% to 11-12%, taking off the destination clause,increasing thequantitynotcoveredby“takeorpay” in thecontract,andshifting from20-year contracts to 10-year contracts. By doing so, they increase flexibility anddecrease price without taking any risks on supply security. Consequently, we do notevenforecastaspottradeof0.6cargoesperdayin2030.Thesupplytargetfor2025forthebiggestplayerinJapan(JERA)is25%gastogaspricein Asia (JKM, JLC, JOE, etc.), 25% henry hub, NBP or TTF related and 50% oil-linked,fromourunderstandingthatpercentageofspotisrelativelyhighcomparedtothisotherJapanese corporations involved in theLNGbusiness.Therefore, the average target forJapanesecompaniesmightbearound15%to20%ofspot trade in2030,representingbetween10.5and14MTPAofLNG (basedona70MTPAdemandwhich is the levelof2010)and0.21to0.35cargoesperday.Anotherproblem for theTokyohub is thatpipelineconnections inside Japanareveryunderdeveloped (ANNEX,Map3.3.1, Japanpipelinemap).Due to the fact that storagefacilitiesarecoupledwithregasterminals,alackofpipelineconnectionsbetweenthemwill make impossible to re-allocate LNG stored in other areas of Japan. Instead of

13

building two new terminals (Soma, Toyama Shinkou) and planning a third one(Wakayama),increasingpipelineconnectionsshouldbethepriority.Inadditiontothat,threemajorcompanieshold50%of thepipelinenetwork, limitingcompetitionon thenetwork side. Low flexibility in stockallocations and fewmarketplayerswill for surenegativelyaffecttheliquidity.Concerningtheregasterminalside,TPA(ThirdPartyAccess) isanimportantfactor inincreasingliquidityonthemarket,byincreasingthenumberofplayers.InJapan,sinceApril 2017 regas terminals’ operators have to announce unused capacities of theirterminals and let other companies use them. In reality,most of the company owningregasterminalsarereluctanttoopenthemtoothers(duetotheinitialinvestment,thelossinflexibility,therelativelyhighrateofutilization,etc.)andthereforeTPAinJapanneed to be studied after one or two years of experience. Since it is really recent wecannotconcludewhetheritdoesnotwork,ortheopposite.Sincenuclearpowerplantshavebeenshutdown,gassuppliersneedtoadjusttoelectricitypeakmanagement,andtherefore regas terminals as well as storage capacity are partially used to adjust toelectricity demand, leaving little room for implementing a TPA. Nevertheless, ifrestartingnuclearpowerplantswillmakeTPAeasier tobe implemented, in the sametime,asitwilldecreasegasdemand,itwillnegativelyaffecttheliquidityongasmarket.Weconcludeherethatrestartingnuclearpowerplantswillhavebothapositiveandanegative effect on the gasmarket liquidity. Theprice, and themodality for the use ofregasterminalsalsodonotappearasperfectlyclear,andincreasedoursuspicionsabouttherealityoffutureTPAinJapan.

ThefiguresinthetableabovemaysuggestthatTPAisdoingwellinJapan,butinrealitythe17regasterminalswhereTPAhavebeenimplementedonlyconcernstruckloading,unlike Europe, where it concerns bunkering, cool-down services, reloading,transhipment and truck loading. Unless nuclear clearly restarts, regas terminals willverybusyandoperatewithfullcapacity,livingnospaceforTPAinotheractivitiesthantruckloading.ForthatreasonweconcludethatsofarthereisnorealTPAinJapan,andweareveryscepticalaboutfurtherTPAdevelopmentinJapan.Concerninggasmarket liberalization, it is true that consumerswill have the choiceoftheirgassupplierfromApril2017;howeverlegalunbundlinginthegaspipelineservicesector(targetingthreelargestcompanies)willbeimplementedfromApril2022.For the electricity sector, legal unbundling between the transmission sector and thedistributionsectorwillstartinApril2020.Therefore,fullcompetitionwillstartin2020in the electricity sector and2022 in the gas sector. In addition, the slowlydecreasingdemand in Japan would also affect liquidity as well as a possible restart of nuclearpowerplants.

TPAimplementedinJapan

Yes No NegotiatesTPA NoinformationRegas

Terminals17

(52%)6

(18%) 9(27%) 1(3%)

Terminalsend-outinmillioncmperyearof

LNG

266,3(57%)

15,3(3%) 182,5(39%) 5,5(1%)

Source:GIIGNL,2017

14

Liquidity couldbedisturbedby thenatureof theproduct itself.Aswedeveloped it inChapterI,liquefactionterminalsrequireimportantinvestments,thusastablecashflowgranted by contracts. Long-term contracts are also important for sellers, decreasingroomforspotcontracts.As we described in part 2.4, the problem of regas terminal accessibility from certainships (Q-Flex and Q-Max) could as well decrease the liquidity on market, so thattransactions may aborted due to ship compatibility problems. In order to assureliquidity on themarket, storage is an important factor. Japandoes have an importantstoragecapacity(12.5MT)nevertheless,storageiscoupledwithregasterminalandthestorageismadeinliquidform,implyingimportantmaintenancecost.Thatmaylimitthenumbersofstoragefacilitiesortheirsize,andhencetheliquidityonthemarket.Apartfromtheliquidityissue,wewillraiseseveralotherissuesthatcouldpreventthehubtobe inTokyo.Thehighlevelofcorporatetaxes in Japan(around31%)isclearlynothelpingfinancialcompaniestradingLNGtoestablishtheirofficesinTokyo.NeitherVitol nor Gunvor have an office in Tokyo, and Glencore, Trafigura only have a smalloffice.This situationdoesnot compare to Singapore,where corporate taxes aremuchlower (i.e. 17%, with possible discounts): currently there are about 30 companiestradingLNGinSingapore,whilethereareonlyJapaneseShousha(商社)inTokyo.

Awell-acceptedandusedindexisalsoneededtoestablishahub.Onthatissue,theEIAwrote:“InSeptember2014,JapanlaunchedanLNGfuturescontractontheJapanover-the-counter exchange (JOE), settled against Rim Intelligence Co.'s Daily Pricing Index.However,onlyonetradehasbeenmadeonJOEsinceitsinception.Thecountry'slackofpipelineconnectivitywithothermarkets, lowvolumesofflexibleLNG,andlackofLNGprice transparencyand liquidityhave contributed to limited spotLNG tradingactivityonJOE.”(EIA,[Online],2015).

To be precise, from September 2014 to March 2017, only one spot transaction tookplaceonJOE.InApril2017TOCOMlaunchedanewversionofJOEinpartnershipwhitPlatts.Butthemainissueremains:“howattractsellersonthatplatform?”,sofartherearenoregisteredsellers(bysellerswewouldrefertogasproducingcompanies)yetontheJOEplatform.TheJOEadvantage(probablytheonlyone)istheanonymityofferedtobuyersandsellers.Havingsaidthat,wecollected(ininterviewsandconversationswithindustrialplayers)the opinion that Tokyo might become a virtual hub, trading vessels prior to themreachingJapan,duetothehighcostnecessarytoimplementaphysicalhub.Wedothinkthatthisstrategywilleversucceedfortwomainreasons:thelimitednumberofvesselsin general, in particular vessels with no destination clause, and the lack of strongfinancialcompaniesinTokyo,whichareneededtoincreaseliquidityleadingtoapriceindex.WhatSingaporecouldachieveinthisfieldmaynotberelevantforTokyo,andwedothinkthatifJapanesecompanieswanttobuyorsellvesselsthepricenegotiationwillbebasedonJKMoranothersufficientlyliquidSingaporeanindex.

15

3.4ShanghaiorSingaporeHub

UnliketheEU,thereisnoregionalcoordinatorinAsiatosetuplawsandregulationsinorderestablishaLNGhub.Europeanregulatorsimplementedthird-partyaccesstothegas transmissionanddistributionassetsandpushed tounbundlevertically integratedcompanies. In addition to that, European Commission declared that destinationrestrictionsandfull-supplylong-termcontractsviolatedEUcompetitionlaw(Kirkness,2016).ThatgavemuchmoreflexibilityforEuropeancontractorandthereforeleadedtotheestablishmentofhubs.ThepathtotheestablishmentofaregionalhubinAsiawillbemuchmorecomplicatedwithoutcoordinatingrole.WedidnotconsiderSouthKoreaasapossiblecompetitortoTokyoforanLNGhubasthecountryhasneverexpressedanywillingnesstoestablishitandalsobecauseofthemonopolyofKOGASongasimport(Platts,2016).In addition to Japan, China and Singapore expressed the wish to establish an LNGtradinghub.WewillseewhichadvantagesbothcouldhaveonTokyo’scandidacy.ASingaporeLNGhubcouldbeasolutionduetoitsgeographiclocation;indeedmostoftheLNGcomingtoJapan,Korea,Taiwan,andChinaarrivesfromtheMiddleEast.“In2015and2016,SingaporehasemergedasareloadingfacilityinAsiaasthecountrydevelopstheinfrastructuresandtradingcapabilitiesneededtosupportitsambitionstobecomeamajorLNGtradinghubintheregion.”(IEA,p57,2016b).Reflecting IEA’s expectations for Singapore,we seen it as a front-runner compared toTokyoandShanghai.MainlybecauseSingapore isatadvantageonseveralpoints:TPAhasbeenwellimplemented,(unlikeJapanandChina);TPAconcernscool-downservices,reloading,storageandtruckloading(pilotfacility).Lowcorporatetaxesattractingfinancialcompanieshavealsoplayedanimportantroleintheappealofthecity-state.TheJKMindexisdoingwellsofar(especiallyJKMswaps),andPlattsmightbeabletouseitsEwindowplatformtoestablishapricediscoverybasedondirectbidandoffer,ratherthanphonecallspriceassessment(thissystemcouldbeimproved by assuring anonymity on the Ewindow platform). In parallel, in 2015SingaporelauncheditsownspotindexforLNG(FOBSingaporeSLIng).ThisSLIngindexis directly competing with the Japanese JOE, even though assessment methods aredifferent.SLInGmethodologyisclosertoJKMPlatts(phonecallassessments)whileJOEpricediscoveryfollowsdirectbids/offersmechanism.Astheliquidityisstillverylowonthemarket,SLInGmethodologymightbemoreaccurateasafirststep,mostlikelythiswill lead to bids/offers price mechanism system when the liquidity will increase.FurthermoreitisinterestingtonoticethatSingaporelaunchedtwotypesofSLInGindex:one Singapore SLInG, and oneNorthAsia SLInG focused on Japan,Korea, Taiwan andChina (EMC, 2016), demonstrating awillingness to establish not only price for SouthEastAsianplayers.The small quantity of storage facility and demand in Singaporemake a physical hubimpossible to implement.Nevertheless, a virtual LNGhub in Singapore for SouthEastAsia (and possibly forNorthAsia aswell) could be totally feasible as the city-state ispoliticallystable,geographicallywell-positioned,attractsnumerousfinancialcompanies(with interesting taxes rates), andappearsneutralbetweensellersandbuyers. Itmaysimply repeat a previously successful path towards oil indexation, which made nowSingaporetheleadingoilpricingspotinAsia.InthatcaseperhapsJKMindexwillreflectNorthEastAsianpricesforLNGwhileSLIngwillbeusedforSouthEastAsia.NorthEastAsiahasdifferentfundamentalsthanSouthEastAsia,consumptionpeaksaredifferent as the climate is different and thus demand peaks do not occur at the sametime.ForthatreasonitappearsimportanttoconsidertheexistenceofatleasttwohubsinAsia(i.e.oneforNorthEastAsiaandoneforSouthEastAsia).

16

A Shanghai LNG hub could be a solution, as Chinese LNG demand is growing veryquickly(+182%inthelast6years).Inaddition,ChinasignedacontractwithRussiaforthedeliveryofup to46MTPAstarting in2018until2048.ShanghaiwillbeconnecteddirectlywiththepipelinefromRussiamostlikelyinthe2020s,ensuringagoodliquidityon the market, so that in a situation of shipping shortage, ships could be loaded atShanghai and sent to Japan, Korea, Taiwan or other south Asian countries. The onlyissuewiththiswouldbethefloorpricepaidbyChinaforRussiangas,estimatedinthe9-11$/MMBtu range, which is much higher than the actual market price (around6$/MMBtu).ThepipelinefromRussiacouldbeasolutionifpricesriseaboveacertainlevel (RT, 2015). Another issue, as pointed out by IEA, is the lack of handoff fromChinesegovernmentonbusiness.Forexample,China'sfivebiggestcrudeoilcompaniesare state-owned (Sinopec, CNPC, CNOOC, Sinochem Group, Shaanxi YanchangPetroleum). Shanghai will also experience the same problems as Japan to establish aphysical hub concerningTPA,market liberalization and so on.Nevertheless, ShanghaicouldbecomeaphysicalhubastheChinawillsoonbecomethefirstimporterofLNGintheworld,withverydiversesupplysources.AveryrecentagreementbetweenUSandChinacomfortuswiththeideathatChinaLNGdemandisgoingtogrowthrapidly,andwithin few years China gas supplywill be fromRussianpipelines,US LNG,AustralianLNGandQatarLNG(Worldoil,2017).Establishingaphysicalhub inShanghaiwill forsuretakea longtimebut inabroaderperspective it appears to us that Shanghai could overcome problems such as thegovernment massive involvement in the economy, infrastructure issues, and marketliberalization.AsthispaperisaboutapossibleTokyohubwewillnotdwellmuchmoreonShanghai, formoredetailsthereadermayrefertothepaperentitled“DevelopinganaturalgastradinghubinChina”(Zhu,2016).ExampleofasimplepathtoestablishanLNGvirtualtradinghub:

Source:Author

Phase1:TPA,fullmarketliberalization

Phase2:Creationofapriceindexforspotcontract

Phase3:Attractinternationalcorporation(winancialinstitution,commoditiestradinghouse)

Phase4:BuyersandSellershavetousethespot

indexplatform

Phase5:Creationofforwardand

futurespriceindex

VirtualHub

17

3.5PossiblesolutionsforaTokyoHub

Inthissection,wewillproposeadditionalmeasuresinordertoestablishanLNGtradinghub in Tokyo. Prior to anymovement to establish a hub in Tokyo, Japan should givemarketvisibilitywithaclearscheduleregardingnuclearpowerplants,asthatwillhaveanimportantimpactontheLNGbusiness.The first step to implementaphysicalhubwill bea totally competitivewholesale gasmarket(includinglegalunbundlinginthegaspipelineservice).Atthesametime,arealandeffectivethirdpartyaccesstopipelines,regasterminalsandstoragefacilities,withpricetransparencyandlawenforcement,shouldbeputinplace.Japanismovingintherightwayconcerningabovementionedpoints,butweregretthatthelegalunbundlingofthegaspipelineservicewillonlystartfromApril2022.Thatfirststepshouldincreasethenumberofmarketplayersonmidanddownstreamside.Japanshouldalsoimprovedomesticpipelineconnectionsinordertoconnectallstoragefacilities to the pipeline network. Building a pipeline connecting Russian productionfrom Sakhalin to Tokyo (ANNEX,Map 3.5, Sakhalin gas pipelinemap) could be also agoodsolutiontoincreaseliquidityonthemarket.Technicalfeasibilityisnotaproblem,but thatwill imply the solution of political issues pending betweenRussia and Japan.ThegoodpointwiththatpartisthatthegovernmentwouldhavemuchmoreleveragetoinitiateapipelineprojectwithRussia.The second step will be to attract international LNG players to trade, based on atransparent and liquid spot index. To achieve that target, we strongly recommend toTokyo to implement fiscal incentives for LNG players wishing to establish thereheadquartersinthecity. Corporatetaxrateisindeedabout31%,muchhigherthaninSingapore(17%)orShanghai’s(25%).Agoodincentivecouldbeforexamplea5-yearcorporatetaxexemption.Currently,taxexemptionsinJapanare,“10%taxcreditforthepromotionof incomegrowthwhereacompanyraiseswagesbyat least5%”or “A taxcredit for job creation (i.e. where a corporation hires new employees)” (Deloitte, p4,2017). In contrast, an approved global trading company in Singapore is grantedconcessionarytaxratesof5%-10%for5-10years.Shippingindustrycouldalsobenefitofconcessionarytaxratesof10%forseveralyears.The last step is, after having a liquid enough spot index, the creation of a derivativemarket in order to hedge physical transaction. As state above, it implies theimplementationofincentivestoattractfinancialcompaniestoestablishtradingdesksinTokyo.Technicalsolutionscouldbefoundtoovercomephysicalissues.Tosolvetheproblemofshipcompatibility, JapancouldprivilegeFLNG(floatingregasterminal),andinsteadofstoringgasinaliquidformitstoreditinagasformlikeinEurope.A path to a virtual hub in Tokyo is as we just envisage is however very unlikely tomaterialise. Nevertheless a possible solution could be -as the trading platform JOEexists- to senda clear signal to themarket that “Japanesecompanies (Shousha(商社),utilities, etc.), agreed to only use JOE platform in order to buy spot cargoes”. If theyadhere to thatprinciple, sellers (suchasQatargas,Chevron,etc.)willbe forced to jointhe platform and price could be assessed almost on daily basis (if you consider thehypothesisofspotdemandof0.3to0.6cargoesperday).Ifthatmechanismisworkingwell,Korean,Chinese,TaiwanesecompaniescouldbeinterestedtoputabidonJOEtoo,leading to improvement in liquidity. Through this scenario JOE index could become areferencespotindexforNorthEastAsia.Inadditiontothat,taxincentiveswillbeverymuchneeded.ThisscenariocouldleadtoimplementTokyoasvirtualhub,butitappearshighlyimprobable.

18

PossiblesolutiontoimplementavirtualhubinTokyo:

Source:Author

Conclusion

ItappearscleartousthattheJapanesegovernmenthasthewillingnesstoestablishanLNGhubinTokyoforspottrade.Nevertheless,whetherTokyowillhavethecapacitytoimplementahubanditislikelytobecometrueinthenextdecadearethetwoisamajorquestion.Despite all issues previouslymentioned, Tokyo has the capacity to become a physicalhubforLNGspottrade,buttoachieveit,importantinfrastructureinvestments(pipeline,storage, etc.) and important changes in contract supply structure from Japanesecompanies (shifting clearly to spot deal instead of long-term contract and becomingmuchlessriskaverse)willhavetotakeplace.Theengenderedcostmightwellbehigherthan the benefits of having a hub in Tokyo. Cost–benefit analysis of implementing aphysicalhubinTokyoneedsthereforetobecarefullystudied. Itdoesnotappearclearforusthatthecost–benefitanalysiswillbefavourabletowardsimplementingaphysicalhubforLNGinTokyo.Furthermoreasmanyplayersunderstoodthataphysicalhubmightbetoocomplicated,theideaofavirtualhubhasbeenconsidered.Tokyoasavirtualhubbasedon JOE index issomethinghard tobelieve,asduring thelastthreeyearsonlyonedealhasbeenusingtheJOEprice.Sellersarereluctanttojointhe platform, and international companies in the LNG business clearly prefer to usePlatts JKM instead. Unless radical changes as expressed in section 4.5 (i.e. JapanesecompaniestakingtheriskofbuyingonlyJOEspotandfuturespriceinordertomakeitliquidenough)weconsiderthatavirtualhubcannotbeimplemented.

JOEcreated(spotandfuturecontract)andtaxincentiveimplemented

JapanesecompaniesonlyuseJOEforLNGspottradeandspottosignorrenewlong-termcontracts

Sellersareforcedtojointheplatform,makingitreal

OtherAsiancompaniesalsojointheplatformtotrade

ToykobecamesavirtualhubforLNGspotandfuturestradingforNorthEastAsia

19

To sum up, considering: the physicals complexities of LNG, the insignificant gasproduction in Japan, the lackof infrastructure,aprice index (JOE) leading toonlyonedealinthelastthreeyears,theclearriskaversionofJapanesecompanies,mistrustfromsellers,theabsenceofpipelineconnectionwithgasfields,therelativelyhighcorporatetax,thedecreasingconsumptioninthenext20years,andtheunclearfuturefornuclearpowerplants,wethinkthatTokyowillneitherbecomeaphysicalnoravirtualhubforLNGspottradeinNorthEastAsia.Inthebestscenario,wethinkthatTokyocouldhaveaspecificspotpriceusedonlybyJapanesecompanies,butthatwillbeaveryilliquidindex.It has been proved that hub location in Asia will have very limited impact on prices(Xunpeng, 2016) andwe could argue that, if a hub is truly needed inAsia and as thelocationwillnotmattermuch,itcouldbemoreinterestingfortheJapanesetohaveanLNGhub in Shanghai. In our opinion, Singaporewill become first (within 10 years) avirtualhubforLNGspottradeandlatterShanghaiwillbecomeaphysicalhub(within20years).

20

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